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Chapter 13
Accounting for Corporations
| Question | Answer |
|---|---|
| Corporation: | a separate entity chartered by the state and legally separate from its owners- that is stockholders. |
| Contributed capital: | stockholders' investments in a corporation, is a major means of financing a corporation |
| Corporations dominate the U.S. economy, in part, because of their ability to.... | raise large amounts of capital; although, sole proprietorships and partnerships are larger in quantity |
| To form a corporation, most states require individuals, called (blank), to sign an application and file it with proper state official | incorporators |
| The application for corporations contains... | articles of incorporation and if approved by the state, these articles, which forms the company charter, become a contract between state and the incorporators. The company is then authorized to do bus. as a corporation |
| board of directors | are elected by stockholders and are the authority to manage a corporation, who carry out corporations policies in their management of the business |
| shared stock | a unit of ownership in a corporation |
| the articles of incorporation states | the maximum number of shares that a corporation is authorized to issue |
| the number of shares held by stockholders is the | outstanding stock |
| board of directors | decides on major bus. policies; among the board's specific duties are authorizing contracts, setting executive salaries, and arranging major loans with the bank |
| dividends | are distributions, among the stockholders, of the assets that a corporation's earnings have generated; only the board of directors has the authority to declare dividends; generally includes several officers of the co.& several outsiders (indep. directors) |
| management | appointed by the board of directors to carry out corporate policies and run day-to-day operations, consists of the operating officers- generally, the president, or chief ex. officer, VP, chief financial officer, and chief operating officer |
| Advantages of incorporation: | separate legal entity, limited liability, ease of capital generation, ease of transfer of ownership, lack of mutual agency, continuous existence, centralized authority and responsibility, professional management |
| Disadvantages of incorporation: | government regulations, double taxation, limited liability, separation of ownership and control |
| Lenders to a small corporation may require the corporation's officers to sign what? | a promissory note, which makes them personally liable for the debt |
| How is equity financing accomplished? | by issuing stock to investors in exchange for assets, usually cash; stockholders can transfer their ownership at will |
| what are two important terms in equity financing? | par value and legal capital |
| par value | is an arbitrary amount assigned to each share of stock; must be recorded in capital stock accounts; usually bears little, if any, relationship to the market value of shares |
| legal capital | is the number of shares issued multiplied by the par value and is the minimum amount that a corporation can report as contributed capital |
| underwriter | an intermediary between the corporation and the investing public- to help with its initial public offering; for a fee-usually less than 1 percent of the selling price- the underwriter guarantees the sale of the stock |
| When are start-up and organization costs recorded? | when they are incurred |
| start up and organization costs include: | (costs of forming a corporation); state incorporation fees,attorney's fees for drawing up the articles of incorporation, the cost of printing stock certificates, accountants' fees for registering the firm's initial stock, other expenditures forming the co |
| What is the reason that start-up and organization costs can be categorized as intangible goods and amoratized over the life of the corporation? | theoretically, they benefit the entire life of a corporation; however, a corporation's life normally is not known, so accountants expense these costs when they are incurred |
| Financing a business by issuing common stock has several advantages: | decreased financial risks(less risky than financing with long-term debt); increased cash for operations (when a company does not pay dividends); better debt to equity ratio |
| Issuing common stock also has certain disadvantages: | increased tax liability (dividends paid on stock are not tax deductible whereas interest on debt is); decreased stock holder control (when stocks are issued it dilutes its ownership) |
| stockholders' equity | owner's claims to the business in a corporation's balance sheet |
| contributed capital | stockholder's investments in the corporation |
| retained earnings | the earnings of the corporation since its inception, less any losses, dividends, or transfers to contributed capital; are reinvested in the business; represent stockholders' claim to assets resulting from profitable operations |
| treasury stock | shares of the corporations own stock that is has bought back on the open market; the cost of these shares is treated as a reduction in stockholders' equity; by buying back these shares the corporation reduces the ownership of bus. |
| statement of stockholders' equity | this statement summarizes changes in the components of the stockholders' equity section of the balance sheet |
| A corporation can issue two types of stock: | common stock and preferred stock |
| common stock | basic form of stock; provide owners with means of controlling the corporation; aka residual equity |
| residual equity | aka as common stock; which means that if the corporation is liquidated, the claims of all its creditors and usually those of preferred stockholders rank ahead of the claims of common stockholders |
| preferred stock | is stock that a corporation may issue to attract investors whose goals differ from those of common stockholders; gives its owners preference over common stockholders, usually in terms of receiving dividends and in terms claims to assets if co is liquidatd |
| authorized shares | maximum number of shares that a corporation's state charter allows it to issue; most are authorized to issue more shares than they need to issue at the time they are formed; able to raise more capital in future by issuing additional shares |
| issued shares | those that a corporation sells or otherwise transfers to stockholders |
| outstanding shares | shares that a corporation has issued and that are still in circulation; treasury stock is not outstanding because the company has put them out of circulation |
| Is preferred stock the same from company to company? | No, preferred stock has many different characteristics and are rarely exactly the same from company to company |
| Do preferred stockholders have a guarantee of receiving dividends? | No; the consequences of not granting an annual dividend on preferred stock vary according to whether the stock is cumulative or noncumulative |
| noncumulative preferred stock | if the stock is this type of stock and the board of directors fails to declare a dividend on it in any given year, the company is under no obligation to make up the missed dividend in future years |
| cumulative preferred stock | the dividend amount per share accumulates from year to year, and the company must pay the whole amount before it pays any dividends on common stock |
| dividends in arrears | dividends not paid in the year they are due; Co. should report this amount either in the body of its financial statements or in a note to its financial statements |
| When preferred stockholders convert their shares to common stock, they gain voting rights but lose? | the dividends and liquidation preference. Conversion back to preferred stock is not an option |
| convertible preferred stock | owners can exchange their shares of preferred stock for shares of common stock at a ratio stated in the preferred stock contract |
| callable preferred stock | that is, the issuing corporation can redeem it at a price stated in the preferred stock contract |
| The call price, or redemption price, is usually.. | higher than the stock's par value |
| When preferred stock is called and surrendered, the stockholder is entitled to the following: | the par value of stock; the call premium; any dividends in arrears; the current period's dividend prorated by the proportion of the year to the call date |
| A corporation may choose to call its preferred stock for any of the following reasons (1): | it may want to force conversion of the preferred stock to common stock because the dividend that pays on preferred shares is higher than the dividend it pays on the equivalent number of shares |
| A corporation may choose to call its preferred stock for any of the following reasons (2 & 3): | it may be able to replace the outstanding preferred stock at a lower dividend or with long term debt, which can have a lower after tax cost; it may simply be profitable enough to retire the preferred stock |
| A corporation cannot declare a dividend that would cause what? | stockholder's equity to fall below legal capital |
| Par value | is the minimum cushion of capital that protects a corporation's creditors |
| no par stock | does not have a par value |
| when a corporation issues par value stock, the appropriate capital stock account (usually common stock or preferred stock) is credit/debit for the par value regardless of whether the proceeds are more or less than the par value. | credited |
| when a corporation issues stock at a price greater than par value, the proceeds in excess of par are credit/debit to an account called ____________. | credited; Additional-Paid in Capital |
| If a corporation issues stock for less than par value, an account called __________ is debited for the difference. The issuance of stock at a discount rarely occurs. It is ______ illegal in many states. | Discount on Capital Stock; illegal |
| When no par stock has a stated value, the stated-value serves the same purpose as ____ _____ in that it represents the minimum legal capital. | par value |
| Most states require that all or part of the proceeds from a corporation's issuance of no par stock be designated as legal capital, which cannot be used unless the corporation is__________. What is the purpose? | liquidated; purpose is to protect the corporation's assets for creditors |
| stated value | state laws require to place this value on each share of stock that they issue, but even when it is not required, a corporation's board of directors may do so as a matter of convenience; can be set by the board unless the state specifies a min. amount |
| If the law is not specific when can the stated value be set? | before or after the shares are issued |
| In establishing the fair market value of property that a corporation exchanges for stock, a board of directors cannot be _____. It must use all the information at its disposal. | arbitrary |
| Can a corporation issue stock in return for assets and services other than cash? | yes |
| Transactions by a corporation issuing stock in return for assets and services usually involve....how is it recorded? | land or buildings or for the service of attorneys and others who help organize the corporation. It is recorded at the fair market value of the stock given up by the Co. or by the fair market value of the assets/services received |
| treasury stock | is stock that the issuing company has reacquired, usually by purchasing shares on the open market |
| Why would a company want to buy back its stock? | to distribute to employ through stock option plans; to maintain a favorable market for its stock; to increase earnings per share or stock price per share; to have additional shares of stock available for purchasing other companies;prevent hostile takeover |
| Treasury stock is not considered a purchase of assets but is a reduction in __________ __________. | stockholder's equity |
| What can a company do with treasury shares? When do they have rights? | can hold treasury stock for an indefinite period or reissue or retire them. Treasury shares have no rights until they are reissued. |
| Treasury shares have no _____ _____, _____ _ _____, or ______ to ______ during liquidation of the company. | voting rights, rights to dividends, or rights to assets |
| What is one major difference between unissued shares and treasury shares? | A share of stock issued at par value or greater and was reacquired as treasury stock can be reissued at less than par value |
| When a firm purchases treasury stock, it is recorded at _____. | cost |
| What happens when a company decides not to reissue treasury stock? | it can retire the stock; all items related to those shares are then removed from the associated capital accounts |
| When the cost of buying back the treasury stock is less than the company received when it issued the stock where is the difference recorded? | Paid-in Capital, Retirement of Stock |
| If the cost is more than was received when the stock was first issued, how is the difference recorded? | the difference is a reduction in stockholders' equity and is debited to Retained Earnings |
| Why would a company's board of directors not declare dividends? | the co. may need the cash for expansion; may want to improve overall financial position by liquidating debt; facing major uncertainties, such as pending lawsuit, strike, or a projected decline in the economy |
| what is liquidated dividend and when does it normally occur? | when a co. does declare a dividend that exceeds retained earnings, it is, in essence returning to the stockholders part of their contributed capital; usually happens when a co. is going out of business or reducing its operations |
| Factors other than earnings also effect the decision to pay dividends. Among them are the following: | industry policies, volatility earnings (co has a period of good earnings followed by period of bad earnings may want to keep dividends low to avoid false impressions); effects on cash flow |
| In recent years, what has caused attitudes to change towards dividends? | a 15% reduction in the tax rate on dividends causing many firms to increase their dividends or start to pay dividends for the first time |
| Three important dates are associated with dividends: | the declaration date, the record rate, and the payment date |
| declaration date | the date on which the board of directors formally declares that a corporation is going to pay a dividend; a legal obligation arises and so a liability for Dividends Payable is recorded and Dividends account is debited |
| In the accounting process, ______ ________ will be reduced by the total dividends declared | Retained Earnings |
| Record date | date on which the ownership of stock, and therefore the right to receive a dividend is determined. No entry is made on this date. Persons who own the stock on the record date will receive the dividend regardless of transfer |
| Between the record date and the date of payment, the stock is said to be... | ex-dividend |
| payment date | the date on which the dividend is pay to the stockholders of record; on this day the Dividends Payable account is eliminated, and the cash account is reduced |
| Two transactions that commonly modify the content of stockholders' equity are: | stock dividends and stock splits |
| stock dividend | is a proportional distribution of shares among a corporation's stockholders; involves no distribution of assets and so it has no effect on assets or liabilities |
| Why would a board of directors declare a stock dividend? | to give evidence of company's success without affecting working capital; reduce the stock market's price by increasing the number of shares outstanding; to make a nontaxable distribution to stockholders; to increase permanent capital |
| Does a stock dividend affect total stockholders' equity? | No, basically it transfers a dollar amount from retained earnings to contributed capital; amount transferred is the fair market value of the additional shares |
| When does GAAP require that the market price be used to account for the stock dividends? | when stock distributions are small- less than 20 to 25 percent of the company's outstanding common stock |
| For a small stock dividend, the portion of retained earnings transferred is determined by? | multiplying the number of shares to be distributed by the stock's market price on the declaration date |
| If financial statements are prepared between the declaration date and the date of distribution, Common stock Distributable should be reported as part of ______ ______. | contributed capital |
| The AICPA has ruled that large stock dividends- those greater than 20 to 25 percent- should be.... | accounted for by transferring the par or stated value of the stock on the declaration date from retained earnings to contributed capital |
| stock split | occurs when a corporation increases the number of shares of stock issued and outstanding and reduces the par or state value proportionally |
| A company may plan a stock split for the following reasons: | to lower its stock markets price per share and thereby increasing the demand and volume of trading for its stock at this lower price; to signal to the market its success in achieving its operating goals |
| The statement of stockholders' equity | summarizes changes in the components of stockholders' equity section of the balance sheet |
| The ending balances on the statement of stockholders' equity appear in the stockholder's | equity section of the balance sheet |
| book value | of a stock represents a company's total assets less its liabilities; simply the stockholders equity in a company and it represents a company's net assets |
| book value per share | the equity of the owner of one share of stock in the net asset of a company; generally, does not equal the amount a stockholder receives if the company is sold or liquidated because, in most cases, assets are recorded at historical cost |
| Book value per share of common stock | if a company has only one common stock outstanding, the book value per share is calculated by stockholders' equity divided by common shares outstanding=book value per share |
| dividend yield calculated by: | dividing the dividends per share by the market price per share |
| return on equity | is the most important ratio associated with stockholders' equity and is a common measure of management's performance; compensation of top executives is often tied to return on equity benchmarks |
| return on equity is calculated by: | dividing net income by average total stockholders' equity |
| the price earnings (P/E) ratio | is the measure of investors' confidence in a company's future |
| the price earnings ratio is calculated by: | dividing the market price per share by the earnings per share |
| Where is the best source of information concerning cash flows related to stock transactions and dividends? | it is the financing activities section of the statement of cash flows |
| What do public companies encourage employees to do? | 98% of public companies encourage employees to invest in their common stock through stock option plans |
| stock option plans | give employees the right to purchase stock in the future at a fixed price |
| What is the purpose of stock option plans? | because the market value of a company's stock is tied to a company's performance, these plans are a means of both motivating and compensating employees; also, compensation expense is tax-deductible |
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